Cumulative market depth is a representation of the cumulative quantity of orders at various price levels in a financial market's order book. It provides insights into the supply and demand for an asset at prices away from the current market price.
Understanding Market Depth
Market depth refers to a market's ability to sustain relatively large market orders without significantly impacting the price of the security. This is often visualized through the order book, which lists outstanding buy orders (bids) and sell orders (asks) at different price levels.
According to the reference, the depth of the market is represented by the cumulative quantity of orders at various price levels. This means that instead of just seeing the quantity of orders at each individual price level, cumulative depth shows the total quantity available up to that price level.
The order book constantly changes as new orders are placed and existing orders are fulfilled. Traders use this information to gauge market sentiment and assess potential price movements or stability.
How Cumulative Depth Works
Cumulative depth is calculated by summing up the quantities of orders as you move further away from the current best bid and ask prices.
- On the bid side: It sums the total quantity of buy orders at or above a certain price level.
- On the ask side: It sums the total quantity of sell orders at or below a certain price level.
This calculation reveals the total volume of potential buying or selling interest accumulating at different price points.
Example: Cumulative Depth Table
Consider a simplified order book:
| Bid Price | Bid Quantity | Cumulative Bid Quantity | Ask Price | Ask Quantity | Cumulative Ask Quantity |
|---|---|---|---|---|---|
| \$100.05 | 50 | 50 | \$100.10 | 40 | 40 |
| \$100.04 | 75 | 125 (50+75) | \$100.11 | 60 | 100 (40+60) |
| \$100.03 | 100 | 225 (125+100) | \$100.12 | 90 | 190 (100+90) |
In this table:
- The "Cumulative Bid Quantity" shows that there are 50 shares buyers want at \$100.05 or higher, 125 shares at \$100.04 or higher, and 225 shares at \$100.03 or higher.
- The "Cumulative Ask Quantity" shows there are 40 shares sellers want to offer at \$100.10 or lower, 100 shares at \$100.11 or lower, and 190 shares at \$100.12 or lower.
Practical Insights for Traders
Traders use cumulative market depth for several purposes:
- Gauging Liquidity: A large cumulative quantity on both sides at nearby price levels suggests a liquid market where large orders can be absorbed with minimal price impact.
- Identifying Support and Resistance: Large cumulative quantities at specific price levels might indicate potential levels of support (on the bid side) or resistance (on the ask side).
- Assessing Order Size Impact: Traders can estimate the potential price impact of placing a large order by comparing their desired quantity to the cumulative quantity available up to certain price levels.
- Understanding Market Sentiment: A significant imbalance in cumulative quantity between the bid and ask sides can suggest bullish (more cumulative bids) or bearish (more cumulative asks) sentiment.
By examining the cumulative quantity of orders, traders gain a better perspective on the overall supply and demand dynamics beyond just the best current prices.
